2022 EPS of $240 vs Street $220? S&P 500 likely further rise +200-400bp from ATH here + markets increasingly agreeing with Fed view of "patience on rates" Array ( [cookie] => b25d67-660272-263e3f-0c7d7c-084cc8 [current_usage] => 1 [max_usage] => 2 [current_usage_crypto] => 0 [max_usage_crypto] => 2 [lock] => [message] => [error] => [active_member] => 0 [subscriber] => 0 [role] => [visitor_id] => 0 [user_id] => 0 [reason] => Usage under limits [method] => ) 1 and can accesss 1

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STRATEGY: Stocks rallying because incoming data increasingly matching Fed view of “patience on rates”
3Q2021 productivity drops to lowest in 40 years: not viewed as inflationary –> proof market moving towards Fed view
Productivity in the US (essentially gap between GDP and labor cost change) dropped to the lowest in 40 years, coming in at -5%. On the surface:

– this is mathematically due to “weak GDP”
– but historically, falling productivity means labor markets heating up
– thus, is normally an inflation signal

Yet, there was no “inflation” reaction in markets:

– 10-year yield fell –> not inflation reaction
– Fed futures show decline in odds of a hike –> dovish reaction
– Cyclical stocks rally –> no “hike” in sight

Futures market see diminished odds of a Fed hike in 2022
In fact, take a look at the probabilities of a Fed hike in June 2022 (we picked mid-2022 for reference) and you can see the odds of a hike have dropped sharply in the past week.

– During September, as inflation fears surged
– Odds of a June 2022 went parabolic
– In past week, these odds are falling sharply

In other words, the market is beginning to agree with the Fed.

BofA and JPM credit card data shows pent-up demand is alive and well –> Epicenter top-line upside
This week, there have been multiple signs that an acceleration of consumer demand is coming. Below is data from BofA credit cards and you can see that travel and services spending:

– Travel spending (airlines + lodging) is growing at 10%-plus
– This is the fastest pace in 2021
– The inflection happened after September
– Just as Delta-variant surge peaked

This is a reminder that COVID-19 trends are having a real-world impact on consumer behavior.

…JPMorgan CC data shows that consumer spending is above 2019 levels
Similarly, the magnitude of this consumer spending recovery is evident below. Credit card spending (CC) by JPMorgan cardholders:

– Spending is +20% versus 2019
– Spending is +5% versus pre-COVID-19 levels
– Acceleration took place after September 2021

By any measure, consumers are embarking on a spending surge, following a decline associated with the Delta-variant surge. At a minimum, it is a reminder that we are not at “peak everything” for consumer spending.

STRATEGY: Year-end rally got “gasoline” this week –> Two things incremental this week: markets beginning to agree with Powell’s view of transitory + Margins to surge +200-400bp past ATH
In the past week, two things stand out:

– Financial markets seem to be starting to agree with Fed view, that inflation risks are transitory (let me explain)
– S&P 500 operating margins are showing little signs of peaking

The dual combination of this strengthens considerably the case for a “everything YE rally.” After all, the case for the stocks to rise is fundamentally stronger:

– not just the “seasonal case” which is strong
– S&P 500 margins expanding = falling equity risk premia + higher EPS
– higher EPS = stock upside
– lower risk premia = P/E expansion

– Fed being patient = falling rates
– falling rates = P/E expansion

So you can see the dual benefit of this improvement in the perception around market risk/reward.

Was this the most important statement from the Fed?
The FOMC press conference on Wednesday was a pivot point for markets. And while many key announcements and statements were made, including the tapering announcement, I think Fed Chair Powell’s most important statement is below:

Powell is making an observation that is logical. It is a multi-part view and something we have written about previously:

– Inflation is visible in the economy now
– Bottlenecks are driving higher prices, given high demand
– Labor markets are also tight now, leading to wage increases
– This tightness, however, is not due to the ‘Philips curve’
– Powell noted the low “employment to population ratio” –> lots of supply of labor out there
– COVID-19 risks, taking care of someone with COVID and other factor keep labor sidelined
– This means, inflation is not due to lack of economic slack

In other words, does it make sense to tighten monetary policy if there is slack in the economy? In fact, Powell did not “maximum employment” is a stronger focus for the Fed.

– This make sense
– Take a look at the capacity utilization of manufacturing and of labor below
– Capacity utilization of assets is only 75%, generally a recession reading

– Employed to population ratio (Labor utilization) is only 59%
-This is the same figure as it was in 2010

Until labor participation recovers, there is plenty of labor slack
Would the Fed have tightened in 2010? It would not have made sense back then. And it would not be appropriate today. The takeaway, in our view, is that until labor participation rates recover, there is plenty of slack.

MARGINS: S&P 500 operating margins at all-time highs and could rise 200-400bp further
S&P 500 operating margins reached an all-time high in 3Q2021 as shown below:

– Operating margin reached 15%
– This is approximately EBIT margin
– Prior ATH was 14% in 2008 and 2014
– Current margin is already +100bp higher

For reasons discussed below, we think S&P 500 margins will surge further from here.

Recall the words of Nietzsche — that which does not kill us makes us stronger.
Before I give our rationale for rising profit margins, there is a key event that impacted all corporates in 2020. They all faced extinction risk as the global economy shut down. Moreover:

– in 2020, no biz had any visibility into 2021 and beyond
– topline collapsed for many companies
– every business “circled the wagon” and re-engineered their processes
– since 2020, every business has faced the risk of constant interruption
– since 2020, every business has faced constantly changing gov’t policy
– since 2020, every business has faced uncertainty of its workforce

This was a depression that no business has seen in 5 generations, or basically since the start of the industrial revolution. Thus, every company in the S&P 500 had to assess how to navigate in this environment.

…Despite surging unit labor costs, margins surging –> PPI is a leading indicator for margin expansion
The chart below is a bit confusing, but shows 3 things:

– Unit labor costs –> 40% of service industry expense
– PPI inflation –> similar to CPI but the inflation for producers
– S&P 500 operating margin

Notice something?

Every surge in PPI has been associated with surges in S&P 500 operating margin. While, at first glance, this sounds counter-intuitive, there is some logic to this:

– inflation happening now while demand robust
– companies therefore “pass through” higher costs
– inflation results in inventory holding gains (buy at lower price, sell at market)
– cost of debt is low, given monetary policy
– in 2021, companies are managing costs stringently
– this is apparent in 3Q2021 calls

Therefore, higher PPI is leading to higher margins.

…ATH margins seen in Discretionary and Technology in 2010 –> mistake to “fade that”
I know there are many who believe in “mean reversion” — therefore, they see all-time high in margins and want to sell that. This would be a mistake, however:

– in 2010, Consumer Discretionary margins hit an all-time high
– the collapse stemmed from the Ch. 11 collapse of GM during GFC

– in 2010, Technology margins hit an all-time high
– this after strugging for a decade post-Internet bubble

…Since 2010, Consumer Discretionary margins further expanded +1,000bp and Technology +400bp
Look at how margins have since progressed for both sectors since 2010:

– Discretionary margins surged to +1,000bp further to 25%
– Technology margins surged +400bp further to 11%

In other words, it would have been a mistake to fade those margin ATH!!!

2022 EPS: Consensus too low at $220? Could EPS be $240 or higher?
Here is the simplest way to contextualize margin upside risk. Take 2022 Consensus EPS:

– Street looking for $220 or so
– Operating margin of 14%
– What if margins are +200 to +400bp higher?

– 2022 EPS would be $256 to $289
– Wow

In other words, S&P 500 EPS could really surprise to the upside in 2022. There are some reasons for this:

– 2022 EPS of $240 means
– Demand surprise –> Global economy recovers?
– Margin surprise –> supply chain glitches ease?
– Margin surprise –> labor shortage eases?
– Margin surprise –> cost re-engineering?

Implied 18.5X 2022 P/E is not that demanding
At $240, S&P 500 is 18.5X 2022 EPS. This does not seem demanding to me:

– 10-yr P/E is 65.5X (inverse of 1.56% yield)
– Investment grade P/E is 47.6X (inverse of 2.1%)
– High-yield P/E is 23.4X (inverse of 4.27%)

So how is an 18.5X P/E for equities expensive? Also, remember many Energy stocks trade at 3X P/FCF. So there are many sectors well below 18.5X.

BOTTOM LINE: Even if Fed announces “taper” this might be inline with market expectations
I realize it feels a bit consensus to be expecting a year-end rally. And it is better when there is a “wall of worry” to climb. The Fed and FOMC could inject some needed worry into the markets. And to an extent, this is a good thing, as long as underlying fundamentals are positive. Still, there are some reasons to remain positive:

– Market is broadening (above)
– Market has positive seasonals (above)
– Economic momentum is broadening as more nations open
– US vaccination efforts are expanding, with boosters and children
– Overall confidence of consumers is strengthening = improved spending

That said, we could see some short-term turmoil around the FOMC. But we would be buying that weakness. Our recommended strategies are:

– Energy
– Homebuilders (Golden 6 months) XHB -0.78%
– Small-caps IWM 0.03%
– Epicenter XLI -0.01%  XLF -0.52%  XLB -0.74%  RCD
– Crypto equities BITO 1.18%  GBTC 1.92%  BITW

Into 2022…
– Industrials

30 Granny Shot Ideas: We performed our quarterly rebalance on 10/25. Full stock list here –> Click here

POINT 1: Daily COVID-19 cases 78,391, up +4,829 vs 7D ago…

Current Trends — COVID-19 cases:

• Daily cases 78,391 vs 73,562 7D ago, up +4,829
• Daily cases ex-FL&NE 75,695 vs 70,337 7D ago, up +5,358
• 7D positivity rate 4.9% vs 5.0% 7D ago
• Hospitalized patients 43,863, down -5.9% vs 7D ago
• Daily deaths 1,096, down -19.8% vs 7D ago

*** Florida and Nebraska stopped publishing daily COVID stats updates on 6/4 and 6/30, respectively. We switched to use CDC surveillance data as the substitute. However, since CDC surveillance data is subject to a one-to-two day lag, we added a “US ex-FL&NE” in our daily cases and 7D delta sections in order to demonstrate a more comparable COVID development.

The latest COVID daily cases came in at 78,391, up +4,829 vs 7D ago. The 7D deltas have been somewhat flat recently, and as seen below, the speed of case rollover appears to be slowing. As booster shots are becoming more widely available, the speed of case rollover should increase once again.

Rolling 7D delta in daily cases is flat…
The rolling 7D delta is currently flat as the speed of case rollover has slowed. As booster shots are becoming more widely available, the speed of case decline should resume and the rolling 7D delta should once again turn negative.

Low vaccinated states seem to have a larger increase in daily cases compared to their recent low…
*** We’ve updated the “Parabolic Case Surge Tracker” to measure case % off recent peak as the more recent “delta surge” is rolling over.

In the table, we’ve included both the vaccine penetration, case peak information, and the current case trend for 50 US states + DC. The table is sorted by case % off of their recent peak.

• The states with higher ranks are the states that have seen a more significant decline in daily cases
• We also calculated the number of days during the recent case surge
• The US as a whole, UK, and Israel are also shown at the top as a reference

Hospitalizations, deaths, and positivity rates are rolling over amidst case rollover…
Below we show the aggregate number of patients hospitalized due to COVID, daily mortality associated with COVID, and the daily positivity rate for COVID.

– Net hospitalizations peaked below the Wave 3 peak and are currently rolling over
– Daily death peaked slightly above the Wave 2 peak and are currently rolling over
– As per the decline in daily cases, the positivity rate is currently rolling over

POINT 2: VACCINE: vaccination pace accelerates as boosters become more widely available…

Current Trends — Vaccinations:

• avg 1.3 million this past week vs 1.0 million last week
• overall, 57.8% fully vaccinated, 66.5% 1-dose+ received

Vaccination frontier update –> all states now near or above 80% combined penetration (vaccines + infections)
*** We’ve updated the total detected infections multiplier from 4.0x to 2.5x. The CDC changed the estimate multiplier because testing has become much better and more prevalent.

Below we sorted the states by the combined penetration (vaccinations + infections). The assumption is that a state with higher combined penetration is likely to be closer to herd immunity, and therefore, less likely to see a parabolic surge in daily cases and deaths. Please note that this “combined penetration” metric can be over 100%, as infected people could also be vaccinated (actually recommended by CDC).

– Currently, all states are near or above 80% combined penetration
– Given the new multiplier. only RI, FL, MA, CT, NM, NY, NJ, IL, CA, PA, DE, SD, KY, UT, OK, ND, NH, AZ, SC, TN, AK, NC, CO, KS, and MN are now above 100% combined penetration (vaccines + infections). Again, this metric can be over 100%, as infected people could also be vaccinated. But 100% combined penetration does not mean that the entire population within each state is either infected or vaccinated

Below is a diffusion chart that shows the % of US states (based on state population) that have reached the combined penetration > 60%/70%/80%/90%/100%. As you can see, all states have reached combined infection & vaccination > 100% (Reminder: this metric can be over 100%, as infected people could also be vaccinated. But 100% combined penetration does not mean that the entire population within the state is either infected or vaccinated).

There were a total of 1,446,434 doses administered reported on Thursday, down 12% vs. 7D ago. We are seeing the vaccination pace accelerate as booster shots are becoming more widely available. Also, the same catalysts remain in place:

• Proof of vaccination required by many US cities and venues
• Booster shots
• Full FDA approval of Pfizer COVID vaccines (hopefully it could help overcome vaccine hesitancy)
• Biden’s vaccination plan

The daily number of vaccines administered remains the most important metric to track this progress and we will be closely watching the relevant data.

72.5% of the US has seen 1-dose penetration > 60%…
To better illustrate the actual footprint of the US vaccination effort, we have a time series showing the percent of the US with at least 45%/45%/50% of its residents fully vaccinated, displayed as the orange lines on the chart. Currently, 100% of US states have seen 40% of their residents fully vaccinated. However, when looking at the percentage of the US with at least 45% of its residents fully vaccinated, this figure is 97.3%. And only 84.7% of US (by state population) have seen 50% of its residents fully vaccinated.

We have done similarly for residents with at least 1-dose of the vaccination, denoted by the purple lines on the chart. While 98.9% of US states have seen 1 dose penetration > 50%, 90.6% of them have seen 1 dose penetration > 55% and 72.5% of them have seen 1 dose penetration > 60%.

This is the state by state data below, showing information for individuals with one dose and two doses.

The ratio of vaccinations/ daily confirmed cases has been falling significantly (red line is 7D moving avg). Both the surge in daily cases and decrease in daily vaccines administered contributed to this.

– the 7D moving average is about ~22 for the past few days
– this means 5 vaccines dosed for every 1 confirmed case

In total, 413 million vaccine doses have been administered across the country. Specifically, 221 million Americans (67% of US population) have received at least 1 dose of the vaccine. And 192 million Americans (58% of US population) are fully vaccinated.

POINT 3: Tracking the seasonality of COVID-19

In July, we noted that many states experienced similar case surges in 2021 to the ones they experienced in 2020. As such, along with the introduction of the more transmissible Delta variant, seasonality also appears to play an important role in the recent surge in daily cases, hospitalization, and deaths. Therefore, we think there might be a strong argument that COVID-19 is poised to become a seasonal virus.
The possible explanations for the seasonality we observed are:

– Outdoor Temperature: increasing indoor activities in the South vs increasing outdoor activities in the northeast during the Summer
– “Air Conditioning” Season: similar to “outdoor temperature”, more “AC” usage might facilitate the spread of the virus indoors

If this holds true, seasonal analysis suggests that the Delta spike could roll over by following a similar pattern to 2020.

We created this section within our COVID update which tracks and compare the case, hospitalization, and death trends in both 2020 and 2021 at the state level. We grouped states geographically as they tend to trend similarly.

CASES
It seems as if the main factor contributing to current case trends right now is outdoor temperature. During the Summer, outdoor activities are generally increased in the northern states as the weather becomes nicer. In southern states, on the other hand, it becomes too hot and indoor activities are increased. As such, northern state cases didn’t spike much during Summer 2020 while southern state cases did. Currently, northern state cases are showing a slight spike, especially when compared to Summer 2020. This could be attributed to the introduction of the more transmissible Delta variant and the lifting of restrictions combined with pent up demand for indoor activities.

HOSPITALIZATION
Current hospitalizations appear to be similar or less than Summer 2020 rates in most states. This is likely due to increased vaccination rates and the vaccine’s ability to reduce the severity of the virus.

DEATHS
Current death rates appear to be scattered compared to 2020 rates. This is likely due to varying vaccination rates in each state. States with higher vaccination rates seem to have lower death rates given the vaccine’s ability to reduce the severity of the virus; states with lower vaccination rates seem to have higher death rates.